Yes, This Is Market Timing: If the CAPE Goes Above 30, Bring on the Larry

[sjwoo]

Reading the Collaborative Fund Bubble article (from viewtopic.php?f=10&t=221821) and also the latest Irrelevant Investor article (from http://theirrelevantinvestor.com/2017/0 ... -scenario/) has me thinking.

Here's where the CAPE looks like right now (from http://www.multpl.com/shiller-pe/):



So. The two times the CAPE has gone over 30, it's resulted in a drastic drawdown. The first time, back in 1929, the drawdown was fairly immediate (down to 22.30 on 1/1/1930). In 1998, it went up two more years and didn't go below 30 until 2002:

Jan 1, 1998 32.86
Jan 1, 1999 40.57
Jan 1, 2000 43.77
Jan 1, 2001 36.98
Jan 1, 2002 30.28
Jan 1, 2003 22.90

I suspect the likelihood of us repeating the heady, ridiculous, etoys.com-fueled climb of the internet boom is highly unlikely. And even if we do, that's fine. I don't care, because I'm 20 years older and don't require that kind of growth anymore because I've held steady through the mortgage crisis.

I know we are not market timers here, but let me float something out and see what you think.

How about switching to the Larry Portfolio right about now? Which of course we know to be:

15% Small Cap Value
15% Emerging Market
70% Intermediate Term Bonds

Seems like if there was ever a time to hedge your bets, it's now with the CAPE threatening to break 30. Of course nobody knows if CAPE hitting 30 means doom and gloom, but I think we are all pretty much in agreement right now that the market is somewhat overvalued.

Looks like the Larry Portfolio rode through the internet boom and bust AOK, though it did get roughed up pretty good during the mortgage crisis (from http://mebfaber.com/2015/07/24/appendix ... portfolio/):

Actually, I'm kind of surprised how badly this portfolio did during the mortgage crisis. With 70% in bonds, why the severe drawdown?

Anyway, this is my thought. And if you are asking when to go back to a traditional 60/40 stocks/bonds allocation, it would be when the CAPE goes below 25. If it doesn't go below 25, then we continue to be in the Larry Portfolio until it does. If it never does, then on with Larry. If Larry can provide 5-6% nominal returns, that's above the traditional 4% withdrawal rate and I'm fine with that.

The question is, do I wait until the CAPE hits 35? Let it ride? More than ever, investing feels like the casino, which is never a good thing...

- Sung

[arcticpineapplecorp.]

Let it ride? More than ever, investing feels like the casino, which is never a good thing...

- Sung

It feels like a casino to you because you are market timing. It does not feel like a casino to me because I choose not to market time. I'm not concerned with what the market does tomorrow, next week, month, year or decade. My time horizon is at least 20-25 years away (and even then I'll still have stocks for the next 30 years if I live to be 100). So what's your time horizon? If it's short term, then perhaps you have too much in stocks and that's why you're nervous. Maybe you want to rethink your asset allocation. Do you have a written IPS (investment policy statement)? Perhaps you want to write one so you're clear on what your trying to accomplish and what risk you're willing to take to accomplish that. Otherwise, you'll keep focusing on the daily movements of the market. Does that help you or hurt you in the long run?

"In the short term the market is a voting machine, but in the long term it is a weighing machine." - Benjamin Graham

[FIREchief]

Making radical changes to a portfolio based on a strictly backwards looking metric, that has never been a consistently reliable predictor of market performance, seems to be extremely risky.

[nedsaid]

The Larry portfolio is 70% Short term treasuries and 30% US and International Small-Cap Value. One that your version of the Larry portfolio didn't do so well during the financial crisis is that your bond benchmark had bonds other than treasuries in it. Pretty much everything fell during the 2008-2009 financial crisis other than nominal treasuries and certain agency bonds like GNMAs. TIPS, Hi-Yield, and Corporate Bonds all got hit rather hard.

[David Jay]

The question is, do I wait until the CAPE hits 35? Let it ride? More than ever, investing feels like the casino, which is never a good thing...

This quote from "Nisiprius" comes to mind:

The stock market is risky. It is a form of greed to believe that there is some easy, effective way to get the risk premium without actually taking the risk. Many people go through a stage in which they engage in delusional thinking:
a) The stock market has had high returns. That's good, I'd like that.
b) The stock market has had high risk. I don't like that.
c) I can't accept "a" and "b" are a package deal.
d) The stock market is risky for everybody else, but not for me, because I can do something clever and get the return without the risk.

[Taylor Larimore]

Pretty much everything fell during the 2008-2009 financial crisis other than nominal treasuries and certain agency bonds like GNMAs. TIPS, Hi-Yield, and Corporate Bonds all got hit rather hard.

nedsaid:

Vanguard's Total Bond Market Index Fund gained +5.1% in 2008 and +5.9% in 2009.

Best wishes.
Taylor

[sjwoo]

It feels like a casino to you because you are market timing. It does not feel like a casino to me because I choose not to market time. I'm not concerned with what the market does tomorrow, next week, month, year or decade. My time horizon is at least 20-25 years away (and even then I'll still have stocks for the next 30 years if I live to be 100). So what's your time horizon? If it's short term, then perhaps you have too much in stocks and that's why you're nervous. Maybe you want to rethink your asset allocation. Do you have a written IPS (investment policy statement)? Perhaps you want to write one so you're clear on what your trying to accomplish and what risk you're willing to take to accomplish that. Otherwise, you'll keep focusing on the daily movements of the market. Does that help you or hurt you in the long run?

My horizon is shorter than yours -- about 13 years. Which is why I suppose I'm thinking about this more than before. 13 is tough...with 20, I wouldn't think twice, I'd just stick with 70/30 and let time be my friend. And with 5, I would definitely be in something like the Larry if not something even more conservative. With 13, if I experience a 30% drawdown, it's gonna be tough to make that up.

The other option, of course, is to just dial back the stock allocation and go 50/50. The part that makes me even more unsure is that bonds don't quite feel like bonds anymore in this low-interest environment. TINA!

[sjwoo]

The question is, do I wait until the CAPE hits 35? Let it ride? More than ever, investing feels like the casino, which is never a good thing...

This quote from "Nisiprius" comes to mind:

d) The stock market is risky for everybody else, but not for me, because I can do something clever and get the return without the risk.

Where do I sign up?

Here's the conundrum. With the current valuations of my portfolio, I'm at about 90% of my desired accumulation for life. I'm not too greedy...I just want enough money so I don't starve in my old age, have a decent place to live, etc.

It's all about risk vs. reward, right? So if I've held on to Boglehead principles and have held on to my allocation all this time, and I'm 9/10th of the way there, doesn't it make sense to let off the gas? Feels like going the Larry way would accomplish that.

[arcticpineapplecorp.]

It feels like a casino to you because you are market timing. It does not feel like a casino to me because I choose not to market time. I'm not concerned with what the market does tomorrow, next week, month, year or decade. My time horizon is at least 20-25 years away (and even then I'll still have stocks for the next 30 years if I live to be 100). So what's your time horizon? If it's short term, then perhaps you have too much in stocks and that's why you're nervous. Maybe you want to rethink your asset allocation. Do you have a written IPS (investment policy statement)? Perhaps you want to write one so you're clear on what your trying to accomplish and what risk you're willing to take to accomplish that. Otherwise, you'll keep focusing on the daily movements of the market. Does that help you or hurt you in the long run?

My horizon is shorter than yours -- about 13 years. Which is why I suppose I'm thinking about this more than before. 13 is tough...with 20, I wouldn't think twice, I'd just stick with 70/30 and let time be my friend. And with 5, I would definitely be in something like the Larry if not something even more conservative. With 13, if I experience a 30% drawdown, it's gonna be tough to make that up.

The other option, of course, is to just dial back the stock allocation and go 50/50. The part that makes me even more unsure is that bonds don't quite feel like bonds anymore in this low-interest environment. TINA!

But bonds are for safety/stability, not for making money. That's what stocks are for. So perhaps you're expecting too much from bonds. That being the case, the amount of risk you take is based on your need, ability and willingness to take risk. You may (or may not) have the need and ability, but it doesn't sound like you have the willingness, so you should work on what your willingness is.

Are you saying you currently have 70/30? If so, the only way you'd suffer a 30% loss is if stocks declined by 45% (or more). Not to say we couldn't suffer a 50% decline at some point in the future, but look at what it took for those kinds of declines to occur in the past:

1. Great Depression
2. 1973-1974 (high inflation, stagnant wages, recession, oil embargo)
3. 2000-2002 (dot com bubble burst, 9-11, recession)
4. 2007-2009 (Great Recession, housing crisis, credit crunch)

Yes, there is perhaps too much leverage in the market (a problem that lead to the great depression).
Yes, we're overdue for a recession but that doesn't mean it has to be prolonged or worldwide.

Otherwise, I'm not so sure anything is similar to past scenarios like those 4 above. Inflation is low. Oil prices are low. Unemployment is low. Companies might be slightly overvalued, but people aren't bidding up companies that have no earnings. People aren't buying houses they can't afford and flipping them.

Anyway, that's not to say when the next recession comes it won't lead to a 20-30% decline. But if it did you're 70/30 portfolio would decrease by 14%-21% (and possibly less depending on how bonds perform...as Taylor said, they wen't UP in 2008 and 2009 which helped offset declines from the stock part of your portfolio).

If you go 50-50 then your max loss for a 20-30% decline in stocks would be 10%-15% (and possibly less depending on those bonds). If that makes you feel better, then perhaps a change is at hand. This is what I mean by your "willingness to take risk". You have to determine how much volatility you can take and still sleep well at night.

[bayview]

The question is, do I wait until the CAPE hits 35? Let it ride? More than ever, investing feels like the casino, which is never a good thing...

This quote from "Nisiprius" comes to mind:

d) The stock market is risky for everybody else, but not for me, because I can do something clever and get the return without the risk.

Where do I sign up?

Here's the conundrum. With the current valuations of my portfolio, I'm at about 90% of my desired accumulation for life. I'm not too greedy...I just want enough money so I don't starve in my old age, have a decent place to live, etc.

It's all about risk vs. reward, right? So if I've held on to Boglehead principles and have held on to my allocation all this time, and I'm 9/10th of the way there, doesn't it make sense to let off the gas? Feels like going the Larry way would accomplish that.

That isn't market timing. That's adjusting your AA as you get closer to retirement, and with the focus of reducing sequence of returns risk.

If your retirement horizon + 90% of goal means that it makes sense for you to be dialing back risk, then that's the lens you should look through. Not what CAPE is or isn't doing. (And I thought that CAPE values today don't match to those in the past due to changes in accounting practices, but I'm afraid I pay so little attention to CAPE that I don't remember the specifics.)

[Peter Foley]

While I agree that the CAPE is high, I have no interest in the Larry portfolio. If I were going to change because of CAPE I would simply replace 10% of my current equities with bonds. I see no reason to adopt an entirely different strategy.

[nisiprius]

...How about switching to the Larry Portfolio right about now? Which of course we know to be:

15% Small Cap Value
15% Emerging Market
70% Intermediate Term Bonds...

Do we?

PortfolioVisualizer says that it is:

JS iShares S&P SmallCap 600 Value ETF 15%
VWO Vanguard FTSE Emerging Markets ETF 15%
TIP iShares TIPS Bond ETF 35%
SHY iShares 1-3 Year Treasury Bond ETF 35%

but doesn't seem to give a source. Notice that SHY is short-term bonds, not intermediate.

My thread, Actual composition of "the" (or "a") "Larry portfolio?" tells of my unsatisfactory search through the pages of Larry Swedroe and Kevin Grogan's Reducing the Risk of Black Swans: Using the Science of Investing to Capture Returns with Less Volatility. It might be any of these. I couldn't tell. I've used the fund names as given in Larry's book although I think some of them are incorrect, as DFA's funds are called "portfolios" and not "index funds."

The final portfolio in Chapter 3, p. 37:

Page 37 Candidate Portfolio

5% S&P 500 Index
5% Fama/French US Large Value Index (Ex Utilities)
5% Fama/French US Small Cap Index
5% Fama/French US Small Value Index (Ex Utilities)
10% Dimensional International Small Cap Index
10% MSCI EAFE Value Index
60% Five-year Treasury Notes

Note that the international fund as called out in the book is not emerging markets.

Page 39 Candidate Portfolio

12.5% Fama/French US Small Value Index
12.5% Dimensional International Small Cap Value Index
75% Five-year Treasury Notes.

Note that the DFA International Small Cap Value Portfolio, DISVX is not emerging markets. According to Morningstar, it's 98.83% deveoped markets. Apparently small-cap-value-ness is considered more important than emerging-market-ness.

Page 43 Candidate Portfolio
14% Fama/French US Small Value Index <--Note: again, raw, not "Ex Utilities"
10.5% "international small cap value stocks"
3.5% Fama-French Emerging Markets Value Index
72% Five-year Treasury Notes

So, Combined Page 43 and 50 Candidate Portfolio, it appears as if an implementation of the "Larry Portfolio" might be:

14% BOSVX, Bridgeway Omni Small-Cap Value
10.5% DISVX, DFA International Small Cap Value Portfolio
3.5% DFEVX, DFA Emerging Markets Value Portfolio
72% "Five-year Treasury notes."

Note that none of the book portfolios contain a high allocation to emerging markets, they are all predominantly developed markets.

Notice that PortfolioVisualizer thinks that the bonds in a Larry Portfolio are half TIPS, but that's not mentioned in the book.

Notice too that over the past few years, Larry has indicated that he personally holds a meaningful allocation to QSPIX, the AQR Style Premia Alternative Fund.

[snarlyjack]

My plan is to keep everything exactly as is & (DCA)
dollar cost average into my fund each & every month.

My mantra is to keep things simple & low cost and
let compounding do the heavy lifting for me...

[sjwoo]

Are you saying you currently have 70/30? If so, the only way you'd suffer a 30% loss is if stocks declined by 45% (or more). Not to say we couldn't suffer a 50% decline at some point in the future, but look at what it took for those kinds of declines to occur in the past:

1. Great Depression
2. 1973-1974 (high inflation, stagnant wages, recession, oil embargo)
3. 2000-2002 (dot com bubble burst, 9-11, recession)
4. 2007-2009 (Great Recession, housing crisis, credit crunch)

Yes, there is perhaps too much leverage in the market (a problem that lead to the great depression).
Yes, we're overdue for a recession but that doesn't mean it has to be prolonged or worldwide.

Otherwise, I'm not so sure anything is similar to past scenarios like those 4 above. Inflation is low. Oil prices are low. Unemployment is low. Companies might be slightly overvalued, but people aren't bidding up companies that have no earnings. People aren't buying houses they can't afford and flipping them.

Anyway, that's not to say when the next recession comes it won't lead to a 20-30% decline. But if it did you're 70/30 portfolio would decrease by 14%-21% (and possibly less depending on how bonds perform...as Taylor said, they wen't UP in 2008 and 2009 which helped offset declines from the stock part of your portfolio).

If you go 50-50 then your max loss for a 20-30% decline in stocks would be 10%-15% (and possibly less depending on those bonds). If that makes you feel better, then perhaps a change is at hand. This is what I mean by your "willingness to take risk". You have to determine how much volatility you can take and still sleep well at night.

Thanks for this -- yup, my current allocation looks like this:

Long-Term Bonds - 20%
Intermediate-Term Bonds - 10%
Largecap Value - 35%
Smallcap/Midcap - 15%
Largecap/Midcap International - 20%

Shaving 5% from the Largecap Value and 5% from the international and putting that into the Intermediate-Term Bonds would certainly be a less drastic portfolio swing...

[Johnnie]

But bonds are for safety/stability, not for making money. That's what stocks are for. So perhaps you're expecting too much from bonds. That being the case, the amount of risk you take is based on your need, ability and willingness to take risk. You may (or may not) have the need and ability, but it doesn't sound like you have the willingness, so you should work on what your willingness is.

Are you saying you currently have 70/30? If so, the only way you'd suffer a 30% loss is if stocks declined by 45% (or more). Not to say we couldn't suffer a 50% decline at some point in the future, but look at what it took for those kinds of declines to occur in the past:

1. Great Depression
2. 1973-1974 (high inflation, stagnant wages, recession, oil embargo)
3. 2000-2002 (dot com bubble burst, 9-11, recession)
4. 2007-2009 (Great Recession, housing crisis, credit crunch)

Yes, there is perhaps too much leverage in the market (a problem that lead to the great depression).
Yes, we're overdue for a recession but that doesn't mean it has to be prolonged or worldwide.

Otherwise, I'm not so sure anything is similar to past scenarios like those 4 above. Inflation is low. Oil prices are low. Unemployment is low. Companies might be slightly overvalued, but people aren't bidding up companies that have no earnings. People aren't buying houses they can't afford and flipping them.

Anyway, that's not to say when the next recession comes it won't lead to a 20-30% decline. But if it did you're 70/30 portfolio would decrease by 14%-21% (and possibly less depending on how bonds perform...as Taylor said, they wen't UP in 2008 and 2009 which helped offset declines from the stock part of your portfolio).

If you go 50-50 then your max loss for a 20-30% decline in stocks would be 10%-15% (and possibly less depending on those bonds). If that makes you feel better, then perhaps a change is at hand. This is what I mean by your "willingness to take risk". You have to determine how much volatility you can take and still sleep well at night.

I hate to ever sound like "it's different this time," but I also can't help noticing on that chart that the lows touched by CAPE in the last two bouts of serious market unpleasantness - 2000 and 2009 - are, respectively, above and in middle of the CAPE range for the long period covered.

Can it be not "different this time" but still look different? Might the things we can see and measure not be the most important things?

I'm 40 percent international - that's another "response" (although it's a plan not a response). Sometimes that doesn't work either. (And sometimes it does - 1970s.)

[Random Walker]

First of all, I don't think there is necessarily one "Larry Portfolio". The Larry Portfolio is simply a very high tilt globally diversified equity compontpent combined with a huge dose of the highest quality bonds. So 30% equities comprised of EMV, ISV, US SV combined with say 70% bonds incorporates that philosophy. But one can incorporate that philosophy with 30% bonds or 80% bonds as well. Rather than specific numbers, the philosophy is to create more of a risk parity portfolio compared to typical 60/40 TSM type portfolio. The Larry Portfolio is more diversified across factors: market, size, value, geography, with big dose safest bonds.
Secondly, one either buys into this strategy for a lifetime or not at all. It is not a market timing strategy. In fact one could say it is the anti-market timing strategy. Not only can we not time markets, we also cannot time factors very well. So if one buys into the concept at all, he should completely buy into the concept of diversifying across factors for the long run. Any of them can perform poorly for a long time. Perhaps ironically, the shorter ones timeframe, the more important it is to diversify across factors. Having only a few year timeframe, there is no way to know how any of the factors will perform. Thus diversifying across them makes sense whether one's time frame is 1 year or 40 years.
I do agree that for those within eyesight of retirement, this is a good time to cool off the AA. Recommend reading Bernstein's Ages of the Investor: Critical Look at Life Cycle Investing. I think it's last chapter where he talks about cooling off AA after a good market run rather than blindly following an age based path.

Dave

[Random Walker]

Also,
Larry has written an article or two in recent past explaining why there is justification for higher CAPE these days. I believe fair to say Larry currently feels market is generously valued with modest future expected returns, but not "over valued".

Dave

[rkhusky]

... but I think we are all pretty much in agreement right now that the market is somewhat overvalued.

I don't agree. The value of the market is determined by what investors are willing to pay for stocks now. The current value of the market has little to do with what it may be worth in a month or a year or 10 years from now.

[HAL 9000]

The cape broke 30 last week. The psychology of the market has nothing to do with the economy. My gut says the youngins are bidding up this bubble so buyer beware. 50/50 seems like a good AA for any age investor.

[am]

Not sure why all this emphasis on what to do now? Many of us have many years of investing left and go through many types of markets and cycles. We will buy and rebalance shares on the cheap sometimes and other times not. Why not just hold tight since has it has been shown market timing don't work? 2 data points of pe>30 followed by a crash doesn't mean it will happen this time. Cape is not a great predictor of future returns- there's a range of outcomes (based on the past).

[David Jay]

And with 5, I would definitely be in something like the Larry if not something even more conservative.

I do not think that Larry would claim that a heavily small-value portfolio is conservative. SCV has underperformed for long periods of time. How would you feel if SCV underperformed the Total Market for the next 10-15 years?

[venkman]

Seems like if there was ever a time to hedge your bets, it's now with the CAPE threatening to break 30. Of course nobody knows if CAPE hitting 30 means doom and gloom, but I think we are all pretty much in agreement right now that the market is somewhat overvalued.

I'll agree that the market is overvalued compared to historical averages, but WHY is it overvalued?

My take on it is:

• Overall wealth has been concentrating more and more toward the top few percent.
• Those few percent can only spend so much; the rest of it they invest. There are only so many investments to go around. Ergo, the price of ALL investments (including bonds) has been bid way up.
• With bonds yielding essentially a 0% real return, investors (in all wealth categories) have turned to stocks more than they normally might, driving down the equity risk premium and driving up stock prices even more.

As long as there is a huge amount of wealth invested by a relative few who have no need to ever pull it out of the market, why should we expect P/E to revert?

The business cycle will inevitably hit a recession, and the market will take a downturn; but I think it will be relatively modest, and stock prices will rebound quickly. Because until interest rates increase, what other choice do investors have if they want a shot at any kind of real return?

[nedsaid]

Pretty much everything fell during the 2008-2009 financial crisis other than nominal treasuries and certain agency bonds like GNMAs. TIPS, Hi-Yield, and Corporate Bonds all got hit rather hard.

nedsaid:

Vanguard's Total Bond Market Index Fund gained +5.1% in 2008 and +5.9% in 2009.

Best wishes.
Taylor

Taylor, Vanguard Total Bond Market Index did well during the financial crisis but it did dip during the crisis. Looking at a growth of $10,000 for Admiral Share class, it reached a high of $10,852 on August 31, 2008. It dipped to $10,462 as of October 31, 2008. It dropped 3.6% but rebounded pretty well. Total Bond is mostly nominal Treasuries and Government Agency bonds. A growth of $10,000 chart for Vanguard Inflation Protected Securities Admiral class reached a high of $11,617 on August 31, 2008 and fell to $10,182 by October 31, 2008 a drop of 12.4%. Vanguard Intermediate Term Investment Grade Admiral Shares (mostly corporate bonds) was at $10,565 on August 31, 2008 and fell to 9,293 by October 31, 2008, a loss of 12.0%. But Intermediate Term Investment grade had been falling since March of 2008.

So my point still holds. Nominal treasuries and government agency bonds did well through the crisis as did Total Bond Market Index. Corporates and TIPS fell and fell hard. All classes of bonds recovered in the aftermath of the financial crisis but nominal Treasuries gave you the best diversification benefit when compared to stocks.

I owned Vanguard Total Bond Market during the crisis and it did well. It did dip slightly but quickly recovered. The Vanguard Intermediate Term Treasury dipped a tiny bit in October of 2008 but it was so slight you could hardly see it on a graph. Intermediate Term Treasuries rebounded smartly in November 2008.

[msk]

With all the "consensus" that the market is over-priced, looks like a good time to buy a Mercedes S Class. After the predicted massive fall it would have cost you the price of a Lexus. Now, how many really predict a massive fall in the near future? Only 50% of market participants (the crowd selling), the other 50% are busy buying more stocks.

[GoldenFinch]

The cape broke 30 last week. The psychology of the market has nothing to do with the economy. My gut says the youngins are bidding up this bubble so buyer beware. 50/50 seems like a good AA for any age investor.

I have a hard time believing that young people have the money to "bid up" the market when there is so much written about student loan debt and younger people not being able to afford buying a house. I'm not saying there isn't "younger people investing" going on, but I doubt it's a big factor in the market run up.

[awval999]

I'm just curious what the PE8 is.

The PE10 takes into account two really bad years, 2008 and 2009. If those years were removed, would the PE8/CAPE number be reasonable?

[lazyday]

The two times the CAPE has gone over 30, it's resulted in a drastic drawdown.

I believe that both times, real interest rates were higher than they are today. So from an equity risk premium perspective, valuations aren't as extreme as it might look from your chart. A few people even argue that equities aren't expensive today, given low interest rates. I quoted Buffett on this elsewhere and can probably find a link if asked.

My bold

And if you are asking when to go back to a traditional 60/40 stocks/bonds allocation, it would be when the CAPE goes below 25. If it doesn't go below 25, then we continue to be in the Larry Portfolio until it does. If it never does, then on with Larry. If Larry can provide 5-6% nominal returns, that's above the traditional 4% withdrawal rate and I'm fine with that.

To me it's key that you are not relying on stocks becoming cheaper than they are today. I do some tactical asset allocation / market timing myself, but wouldn't sell so much equity that my retirement would suffer if equities stay expensive for the rest of my life.

The question is, do I wait until the CAPE hits 35?

Going from 60/40 to 30/70 seems pretty extreme. Maybe you could go part way there now, and later decide if you want to go further. Personally I'm not convinced the value and small premia will be large enough in the future for a 30/70 Larry Portfolio to match the returns of a 60/40 market portfolio. Especially if you aren't using deep value funds like Larry uses, such as DFA's.

The other option, of course, is to just dial back the stock allocation and go 50/50.

You could go 50/50 and moderately increase your SV, V, and/or EM tilts. The Larry Mini.

[nisiprius]

...First of all, I don't think there is necessarily one "Larry Portfolio". The Larry Portfolio is simply a very high tilt globally diversified equity component combined with a huge dose of the highest quality bonds...

If we don't have any clear description of what it is, or any authoritative example of a "Larry Portfolio," then there's no way to backtest it, and it's not even clear how we would adopt it. It becomes something like saying "if the CAPE goes about 30 I will switch to a GARP strategy" or "if the CAPE goes above 30, I will start investing like Warren Buffett."

It seems to me that in any case, the Larry Portfolio either makes sense or it doesn't. It's something that's intended to be a long-term strategy. It's not a CAPE-modulated strategy that varies according to valuation, it's just buy-and-hold. So, if you have decided that the Larry Portfolio is superior to what you are using now, you should just switch to it, regardless of market conditions, and the sooner the better so that your "long term" can begin as soon as possible.

By the way, one thing I admire about the Larry Portfolio is that it's the only thing I can recall seeing written in which someone suggests using riskier assets and adjusts the portfolio so that the portfolio risk stays the same.

[lazyday]

Just saw this:

I'm at about 90% of my desired accumulation for life. I'm not too greedy...I just want enough money so I don't starve in my old age, have a decent place to live, etc.

Ok, maybe going from 60/40 to 30/70 isn't extreme for you, like I said above. If you're already close to your goal and still have years to save, are uncomfortable with the expensive stock market, and have realistic SWR assumptions for your planned retirement age, I see no reason not to go for it!

Oh, and you might consider TIPS replacing a big chunk of the nominal Treasuries to reduce inflation risk.

[siamond]

OP, you showed a graph illustrating the trajectory of the CAPE. In the past, 1/CAPE did provide a half-decent signal about expected real (inflation-adjusted) returns for the next decade, but in the midst of a LOT of random noise. The average/mean CAPE means very little (it went all over the place in the past, and there are good reasons for it to shift over time).

What you didn't show is the trajectory of interest rates. Here they are, courtesy of multpl.com.



Interest rates are typically very close to bond yields, which historically have been a pretty good indicator of nominal (incl. inflation) returns in the coming decade. By no mean a perfect forecasting system, but definitely much better than anything CAPE-based for stocks. Subtract 2% inflation (Fed target) and you're left with... nothing much.

Now tell me, if we accept your premise of changing your portfolio based on the current situation (and we really should NOT), do you REALLY want to go with a portfolio using 70% bonds? Meaning to make a bet that the notoriously capricious Small-Cap-Value and Emerging Markets (30% of your portfolio) will do all the work for you in the coming decade? Er, maybe not?

One more thing, I don't know what is the current CAPE for SCV, but the PE of the corresponding Vanguard fund (VSIAX) is 43x. While the PE of the S&P 500 Vanguard fund (VFIAX) is 24x. Meaning that the SCV sub-category appears to be way more over-valued than the S&P 500...

[Top99%]

Now tell me, if we accept your premise of changing your portfolio based on the current situation (and we really should NOT), do you REALLY want to go with a portfolio using 70% bonds? Meaning to make a bet that the notoriously capricious Small-Cap-Value and Emerging Markets (30% of your portfolio) will do all the work for you in the coming decade? Er, maybe not?

One more thing, I don't know what is the current CAPE for SCV, but the PE of the corresponding Vanguard fund (VSIAX) is 43x. While the PE of the S&P 500 Vanguard fund (VFIAX) is 24x. Meaning that the SCV sub-category appears to be way more over-valued than the S&P 500...

You touch on my two big concerns with the Larry Portfolio:
1) The bet on bonds which have a) been in a bull market for a long time and b) have their own deep risks (mainly not keeping up with *unexpected* inflation)
2) The bet on small value (which as you point out is very richly valued)
I have read most of Larry's books and have tremendous respect for him but I am not willing to bet my entire financial future on a Larry style portfolio. So, I need some total market and alternatives mixed in to sleep at night.

[sjwoo]

I just want to say how much I love you guys. Seriously. The conversation here has been so insightful. Sometimes I think it helps just to talk about what I might want to do -- akin to shooting blanks out of a gun. Sometimes I feel like I need to pull the trigger, and chatting about it with you folks helps a great deal to relieve that pressure. Bogleheads are like an AA group for finance!

[HomerJ]

Here's the conundrum. With the current valuations of my portfolio, I'm at about 90% of my desired accumulation for life. I'm not too greedy...I just want enough money so I don't starve in my old age, have a decent place to live, etc.

This is the right reason to change your AA to be more conservative.

Changing your AA based on market conditions is a bad reason.

Your plan of going back and forth based on valuations is not a good idea. You are 90% there, 13 years from retirement... Dial it back, and keep it dialed back. A stock market crash can happen anytime. Maybe even tomorrow. This is ALWAYS true. Base your AA on how close you are to retirement and how much you have.

I'm 7 years from retirement, and I'm 50/50. In a few years, I may drop to 40/60. I don't care about CAPE. I would be 50/50 right now, regardless of CAPE. It's a terrible measurement tool for timing the market. People like to say it's the "best" of a bunch of bad tools, but it's still a terrible tool. A screwdriver is the "best" tool for driving in a nail, if all you have is a screwdriver and a saw, but it's still a terrible tool for that job.

[Top99%]

I just want to say how much I love you guys. Seriously. The conversation here has been so insightful. Sometimes I think it helps just to talk about what I might want to do -- akin to shooting blanks out of a gun. Sometimes I feel like I need to pull the trigger, and chatting about it with you folks helps a great deal to relieve that pressure. Bogleheads are like an AA group for finance!

+1. I have learned *so* much from the threads and links on this forum. I hope to add my own value some day.

[siamond]

Bogleheads are like an AA group for finance!

This isn't the first time I've heard this analogy. I think it's a good one. We all have impulses, this is part of human nature. Being able to discuss them goes a long way in being able to control them.

[siamond]

I have read most of Larry's books and have tremendous respect for him but I am not willing to bet my entire financial future on a Larry style portfolio. So, I need some total market and alternatives mixed in to sleep at night.

Same here. It is true that said portfolio backtests surprisingly well (at least in the US - I tried and showed outcomes in a past thread), but the reasoning lacks a strong rationale, its past performance might be more luck than anything (i.e. a fortunate confluence of events), and today's situation seems to speak especially against it. I would be mildly curious to see if it would have worked well for investors located in other countries, which I don't believe has been demonstrated, but would certainly NOT bet my life's savings on such approach. I do use an SCV and an EM tilt, but added to a TSM + Total Int'l backbone...

[Da5id]

I'm 7 years from retirement, and I'm 50/50. In a few years, I may drop to 40/60. I don't care about CAPE. I would be 50/50 right now, regardless of CAPE. It's a terrible measurement tool for timing the market. People like to say it's the "best" of a bunch of bad tools, but it's still a terrible tool. A screwdriver is the "best" tool for driving in a nail, if all you have is a screwdriver and a saw, but it's still a terrible tool for that job.

Just curious, who are the people who say it is useful for timing the market? Not Shiller, its creator. In fact, I'm not aware of many (any?) reputable sources who argue for that. The base you can say about CAPE is that it gives some indication of likely dispersion of returns over next 10 years, and even then it doesn't account for a good part of those returns. So who are these people you refer to?

[Portfolio7]

I have been changing my AA every couple of years (or more frequently) for 22 years of investing. Mostly it was trying to incorporate new knowledge, but the point is that it doesn't appear to have hurt my performance any. I think what's most important is to have a reasonable AA at all times (and not be performance chasing.)

I admit I keep looking at something like one of the Permanent Portfolio variants, or the Golden Butterfly (Portfoliocharts.com) when it comes to a retirement portfolio. Eliminate the early 1970's and they still seem remarkably stable, enabling higher safe withdrawl rates.. I haven't built a plan around this, so it's more of a 'project' to determine if this is appropriate for my personal investment plan.

[HomerJ]

I'm 7 years from retirement, and I'm 50/50. In a few years, I may drop to 40/60. I don't care about CAPE. I would be 50/50 right now, regardless of CAPE. It's a terrible measurement tool for timing the market. People like to say it's the "best" of a bunch of bad tools, but it's still a terrible tool. A screwdriver is the "best" tool for driving in a nail, if all you have is a screwdriver and a saw, but it's still a terrible tool for that job.

Just curious, who are the people who say it is useful for timing the market? Not Shiller, its creator. In fact, I'm not aware of many (any?) reputable sources who argue for that. The base you can say about CAPE is that it gives some indication of likely dispersion of returns over next 10 years, and even then it doesn't account for a good part of those returns. So who are these people you refer to?

Every person who suggests changing your AA because valuations are "high".

Not a small, hidden group. I'm surprised you're unaware of them on the Internet and on these boards.

[feh]

My horizon is shorter than yours -- about 13 years.

Unless you know the date of your death, you can't say this. If you are eyeing retirement in 13 years, your horizon is quite a bit longer than that.

[whodidntante]

I think it's a bad idea. Bonds are as "overvalued" as stocks are. You have this double whammy of very low yields and upward pressure on yields. Bonds could get a thumping that we haven't seen in a while. I'm not going to tactically put 70% of my portfolio in that.

I'm well aware that someone is considering hitting the reply button to add that bonds are incredibly safe compared to stocks, and such and such bond index only lost 5% in the last 20 years or whatever. I'm not advising against owning bonds. I'm advising against a 70% tactical allocation to bonds.

[Da5id]

I'm 7 years from retirement, and I'm 50/50. In a few years, I may drop to 40/60. I don't care about CAPE. I would be 50/50 right now, regardless of CAPE. It's a terrible measurement tool for timing the market. People like to say it's the "best" of a bunch of bad tools, but it's still a terrible tool. A screwdriver is the "best" tool for driving in a nail, if all you have is a screwdriver and a saw, but it's still a terrible tool for that job.

Just curious, who are the people who say it is useful for timing the market? Not Shiller, its creator. In fact, I'm not aware of many (any?) reputable sources who argue for that. The base you can say about CAPE is that it gives some indication of likely dispersion of returns over next 10 years, and even then it doesn't account for a good part of those returns. So who are these people you refer to?

Every person who suggests changing your AA because valuations are "high".

Not a small, hidden group. I'm surprised you're unaware of them on the Internet and on these boards.

OK, you mean random posters rather than organizations like Vanguard or generally respected figures. Fine. I also see people arguing for gold etc.

I've yet to see a coherent CAPE based market timing scheme that anyone actually can make a good case for, presumably because there isn't such a viable scheme. I see people like Bogle suggesting that returns will be depressed going forward due to CAPE/valuations, but that isn't a call to market timing.

[sjwoo]

My horizon is shorter than yours -- about 13 years.

Unless you know the date of your death, you can't say this. If you are eyeing retirement in 13 years, your horizon is quite a bit longer than that.

I suppose what I was saying was that in 13 years, I'll start withdrawing from the 401k, so at that point, I'll need to seriously reassess my allocation (or, more smartly, would've been changing my allocation along the way so year 13 doesn't mean so much).

[XdUzHa3NtSeIkBkIGPVn]

By the way, one thing I admire about the Larry Portfolio is that it's the only thing I can recall seeing written in which someone suggests using riskier assets and adjusts the portfolio so that the portfolio risk stays the same.

I believe the Larry portfolio was meant to target the same return with less risk.

One more thing, I don't know what is the current CAPE for SCV, but the PE of the corresponding Vanguard fund (VSIAX) is 43x. While the PE of the S&P 500 Vanguard fund (VFIAX) is 24x. Meaning that the SCV sub-category appears to be way more over-valued than the S&P 500...

The PE of VSIAX is 17.29. It wouldn't be value if it wasn't priced lower than the market average

I have read most of Larry's books and have tremendous respect for him but I am not willing to bet my entire financial future on a Larry style portfolio. So, I need some total market and alternatives mixed in to sleep at night.

Same here. It is true that said portfolio backtests surprisingly well (at least in the US - I tried and showed outcomes in a past thread), but the reasoning lacks a strong rationale, its past performance might be more luck than anything (i.e. a fortunate confluence of events), and today's situation seems to speak especially against it. I would be mildly curious to see if it would have worked well for investors located in other countries, which I don't believe has been demonstrated, but would certainly NOT bet my life's savings on such approach. I do use an SCV and an EM tilt, but added to a TSM + Total Int'l backbone...

It has been demonstrated on a large enough sample of US equities that it's statistically very unlikely to be "chance". The value premium also has been found to exist on every country's stock market that we have data on.

However, you can argue that its returns will likely be lower in the future, so you can't just use historical data and project forward. I'd definitely be a little worried with just 30% equities.

I think it's a bad idea. Bonds are as "overvalued" as stocks are. You have this double whammy of very low yields and upward pressure on yields. Bonds could get a thumping that we haven't seen in a while. I'm not going to tactically put 70% of my portfolio in that.

I'm well aware that someone is considering hitting the reply button to add that bonds are incredibly safe compared to stocks, and such and such bond index only lost 5% in the last 20 years or whatever. I'm not advising against owning bonds. I'm advising against a 70% tactical allocation to bonds.

The short term bonds from the Larry portfolio have a lot less downside risk than intermediate or longer. Higher rates? Unexpected inflation? It won't dent you almost at all. However, you won't get much return, either. If you wanted that strategy, you'd probably do much better with CDs, with the same or less downside risk.

[sjwoo]

I think it's a bad idea. Bonds are as "overvalued" as stocks are. You have this double whammy of very low yields and upward pressure on yields. Bonds could get a thumping that we haven't seen in a while. I'm not going to tactically put 70% of my portfolio in that.

I'm well aware that someone is considering hitting the reply button to add that bonds are incredibly safe compared to stocks, and such and such bond index only lost 5% in the last 20 years or whatever. I'm not advising against owning bonds. I'm advising against a 70% tactical allocation to bonds.

This is quite the conundrum. If stocks are overvalued and bonds are too, the only safe asset left is cash, but that's not safe, either, due to inflation...so set your SWAN allocations, take the drubbing that's obviously going to come at some point, and just deal with the inevitable drawdown.

One thing that I just noticed (because I'm slow!) is how low volume this latest climb has been, looking at the DJIA:



It's not until the end of last year and this year that volume has more than doubled since about 2013-2014.

[feh]

It's not until the end of last year and this year that volume has more than doubled since about 2013-2014.

You are watching the market too closely. There will likely be at least 2 recessions between now and when you expect to retire. Get used to the idea.

Set your AA at what you can sleep with and turn off CNBC.

[lazyday]

Changing your AA based on market conditions is a bad reason.

For the most part I agree with you, but I think it may help to have an eye on valuations when considering AA decisions.

People often make excuses to increase risk after risk assets have done well and are expensive, or decrease risk when they are cheap.

"My willingness to take risk has changed so I should change my AA!"
"I didn't estimate correctly!"
"I just didn't know before!"

Ignoring the Larry Portfolio for a moment: If someone wanted to suddenly switch from 60/40 to 30/70 after a market crash, with low CAPE and high expected returns, we might consider advising restraint. Even if their reasons seem legitimate. But if CAPE is high and expected returns are low, and their reasons seem legitimate, maybe we shouldn't be discouraging--even if the change seems a little extreme.

[JRB22]

OP, you showed a graph illustrating the trajectory of the CAPE. In the past, 1/CAPE did provide a half-decent signal about expected real (inflation-adjusted) returns for the next decade, but in the midst of a LOT of random noise. The average/mean CAPE means very little (it went all over the place in the past, and there are good reasons for it to shift over time).

What you didn't show is the trajectory of interest rates. Here they are, courtesy of multpl.com.



Interest rates are typically very close to bond yields, which historically have been a pretty good indicator of nominal (incl. inflation) returns in the coming decade. By no mean a perfect forecasting system, but definitely much better than anything CAPE-based for stocks. Subtract 2% inflation (Fed target) and you're left with... nothing much.

Now tell me, if we accept your premise of changing your portfolio based on the current situation (and we really should NOT), do you REALLY want to go with a portfolio using 70% bonds? Meaning to make a bet that the notoriously capricious Small-Cap-Value and Emerging Markets (30% of your portfolio) will do all the work for you in the coming decade? Er, maybe not?

One more thing, I don't know what is the current CAPE for SCV, but the PE of the corresponding Vanguard fund (VSIAX) is 43x. While the PE of the S&P 500 Vanguard fund (VFIAX) is 24x. Meaning that the SCV sub-category appears to be way more over-valued than the S&P 500...

On this last point-- Isn't "value" investing based on selecting funds with relatively low PE ratios? If so, how is it that a broad index of "value" based funds has such a remarkably higher PE than the S&P 500?

[lazyday]

[lazyday snipped] Bonds are as "overvalued" as stocks are.

This is quite the conundrum. If stocks are overvalued and bonds are too, the only safe asset left is cash, but that's not safe, either, due to inflation

Some people think long term nominal bonds are expensive today, but you don't need to own them; see the end of the post above yours.

TIPS, even long ones, might be useful in a "Liability Matching Portfolio" if you haven't read about that yet. Some consider them to be the safest asset.

[siamond]

One more thing, I don't know what is the current CAPE for SCV, but the PE of the corresponding Vanguard fund (VSIAX) is 43x. While the PE of the S&P 500 Vanguard fund (VFIAX) is 24x. Meaning that the SCV sub-category appears to be way more over-valued than the S&P 500...

The PE of VSIAX is 17.29. It wouldn't be value if it wasn't priced lower than the market average

Er, no. First, you're quoting the price to *prospective* earnings, and probably got this number from Morningstar here. Morningstar does all sorts of strange things with their PE computation (see more details on the corresponding Wiki page), and the worst sin of all is to use prospective (aka forward) earnings, which is basically analysts guessing future earnings with all their biases enabled...

I was quoting the VSIAX Vanguard number, which can be found here (check the portfolio tab). Vanguard, unsurprisingly, does it much better than Morningstar, and provides price to *past* earnings (trailing twelve months), hence something factual.

Next, as to the fact that the SCV PE is much higher than the S&P 500 PE, well, SCV is made of small-caps while S&P 500 is made of large-caps blend (mixing value and growth). So we have two factors at play here, value and size. Now let's compare apple to apple, using Vanguard's numbers.

S&P 500 (Large Cap Blend) vs. Large Cap Value: VFIAX PE is 24, while VVIAX PE is 21, which makes sense.

Small Cap Blend vs. Small Cap Value: NAESX PE is 69, while VSIAX is 43, which makes sense. And amazingly enough, the PE for Small-Cap Growth (VSGAX) is a mind-boggling 259.

On this last point-- Isn't "value" investing based on selecting funds with relatively low PE ratios? If so, how is it that a broad index of "value" based funds has such a remarkably higher PE than the S&P 500?

Same answer as above. Was an interesting point!